FedEx: Anytime, Anywhere - [Business Breakdowns, EP.135]

25:57And so I don't think anybody would have said they're a great aggressive pricer at that point, But then they got religion on that over the last decade. And so you've seen pricing be probably the best of any of their three segments. You've seen the margins come with it. So they're at an incredible 20 % margin right now. Even in this particular year where it's down comparisons, it's still over 20. You're exactly right. Gold Dominion is the gold standard as far as all the performance measures, which certainly shows up in its value as a sidebar. FedEx is just maintaining the yield while giving up some of the volume while keeping the margin, which has been an incredible margin progression.

26:36Yeah, that is quite impressive. I did not realize that it had gotten to that level. So when you step back from the business, you look at the opportunity set that they have and where capital should be going next and where capital is going next in terms of the investment opportunities. How do you frame that? How does the business think about this in terms of where the dollars are going to be spent in the future and setting up the business best for future success? It's a great time to ask that question because I think it's so trite and overhyped to say, we're at an inflection point. So I'm going to say, I think we're at an inflection point.

27:11I can't help it. Because to your point, if you just go segment by segment, within Express for the longest time, it was covering more parts of GDP or getting certain rights, especially importantly, refleting the airplanes, all that stuff is done. So they have really good disclosure on the makeup of their CapEx and they show you what the airplane CapEx, been a bubble for a while, but the big growth in that has been, they now have a younger fleet age than UPS, which is interesting on the airplanes. So that's about to be done. And they tell you that's going back to a billion dollars on that spending of a maintenance level.

27:46So on Express, it's almost like as the refleting finishes, there's nothing left to do there really other than be it DNA. And then at ground, you had a huge asset explosion. Over this 10 years where we talked about the margin going down, the revenues were exploding because, yes, the margins were being hurt by e -commerce and B2C, but it made the assets and the revenues explode, not in a great return way. But nonetheless, all that bulge is also coming to a close. So they also talk about the ground segment CapEx moderating and say that gets back to call it DNA as a proxy, leaving you with freight, which is they're not going to be allowed to buy much more freight.

28:25They're the number one leader by far. It's interesting to look at Old Dominion's market cap, even though they're at a distant number two to FedEx LTL, but they're not going to buy anything there. That just leads to this, it's finally time for shareholder return. So the yield is only a couple of percent, even though the growth rate on that is good. but for a very recent part of the multi -decade period we've covered it, they are seriously in the share repurchase business now. So that's running at about a three and a half to 4 % a year buyback pace on top of the dividend. And that's pretty meaningful, especially now when you are in this final refleting part.

29:04So the key thing is if you looked out two to three years and CapEx really does go to something like DNA, which by the way, that was always what was knocked on this company, as you know, you've known this comparison forever, people would say, oh, there's no quality of earnings at FedEx, meaning they didn't convert all their cash flow into free cash flow to equally EPS. That's finally on the horizon. That should finally happen in two to three years. And that would leave an even more available money for a higher dividend and more share repurchase. But for now, while the CapEx is still larger than the DNA, long -winded way to say that's pretty much It's just going to the dividends and the share repurchase.

29:43What you see is step downs in the refleeting of the planes. Are there any type of sortation facilities or anything happening within the network that is going to require material CapEx spend? And what else might fall into that bucket in the future that you think about or you have your eyes on? Because I agree, it has been this incredibly hot topic when it comes especially to UPS. versus FedEx as an investor debate. Are there anything else that is top of mind for you in terms of watching that could fall into the CapEx category in the future? The answer to that actually segues into one of their big news flashes over the last year or so is this one FedEx, the consolidation of these three segments that we keep talking about now into this one operating entity other than freight.

30:33Freight is the one thing that would stay off to the side. But as they do merge this, it really goes the other way because they just ran these independently for so long. And it was really in the name of speed and service. They didn't want to compromise that. But all of it has grown so much and that has gone for so long that there really is just some basic redundancy now. So there are way more chances now for the freight part to carry for ground. And there are way more times when you don't need an express truck in the same neighborhood as a ground truck. So to your question, if anything, it's now rationalizing capacity instead of still adding to it.

31:11You can see the breakneck ad when the ground assets over the last decade have done something like going from $8 billion -ish to $32 or $3 billion -ish now. I mean, it's been that order of magnitude. So if anything, it's time to take a breather, pause, even pay to close some of that down. They've talked about some of the cost of downsizing, but with a very good payback. So long -winded way to say, I think we're going the other direction on that instead of where does it expand? And I'll bring up what might be a sensitive topic for an investor. FedEx years ago purchased TNT as a large acquisition abroad, and TNT was going to be a nice piece to add into their network.

31:53But the integration faced a lot of challenges in terms of taking that one network and implanting it into the FedEx network. When you take that history and now apply it to what they're trying to do with one FedEx in the US, has the management team talked at all about maybe lessons that they've learned from that, that they can apply to avoid any of those mishaps or operational issues when it comes to integration? That's a great question because as you're right, that has not been the textbook, great case study of acquisition. And some of that is they had this huge cyber attack and you could argue, is it their fault for not doing the diligence or addressing it?

32:31Or is it totally not their fault because they were targeted? Whatever reasons, all stuff and then French airport rules, you name it, they had it. Now, what's interesting about that one is that the synergies on day one that they advertised were enormous compared to the price. So I think they said something like 750 million of synergies on a sub $5 billion price, even though there are 7 billion of revenues there. So that was such a fat pitch that even a mess for the first few years of integration, that alone was still there all the time. And then on top of that, what they would talk less about, because nobody wants to talk much about tax if you're going to lower it to flag it for all governments, but a Netherlands domicile also helps if you look through some of the foreign tax rate stuff, and that wasn't in the synergy number.

33:19They are finally getting to a point this year where actually it's hard to get the exact numbers, of course, on synergies at this point. But this is the year that TNT has finally been consolidated. I mentioned the headwind of some of the express surcharges after the pandemic, but against that, they have finally gotten some of these synergies. So on TNT, first, just on that, I think it's fair to say that finally is paying off. And then even with the lag though, I don't think they'd regret doing it. I think they would regret some of the tactical stuff on how that got done. And then on the part of your question about lessons learned there, I think just because it's more putting, it's getting more stuff onto the ground network in Europe, but some of that is so Europe specific, like the truck sizes are different and all the different country to country rules that you're trying to simplify.

34:10I'm not sure how analogous that ends up being, but there may be benefits there that I'm not seeing or aware of, but I'm not sure there's a lot directly applicable. It's probably better if there's not much that's directly applicable. If it's a completely different situation, it might make for a completely different integration process. But I agree. It felt a situation where one thing after the next was happening in terms of bad events and something like the cyber attack. To your point, there could have been maybe more diligence done, but you look at the other major transportation companies that were hit, like Maresk, you could point to a finger at a lot of different companies when it comes to who was impacted and affected there.

34:54I guess the other piece of the consolidation is what that could do to the overall margin profiles. I think we've talked a lot about these businesses separately in different segments. But when you consolidate everything together, what does it look like for FedEx? And maybe a quick rundown of the income statement in terms of how you would frame it from a revenue margin perspective and how you would think about those two things trending in the future. Our best guess at how to put that together is we take Express and Ground and mash them together. And then we do the same for UPS, Domestic and International and take a look at that.

35:31And And to your point implied there, it's telling, it does show the opportunity. Because if you match those things together with UPS, that operating margin has been really pretty steady around 14%. And if you match together express and ground for FDX, it never really gets to a double digit. It's eight to nine. If you use that to frame these drive savings, drive is the acronym for the cost stuff that we've talked about that they're doing. They talk about that as a total number of $4 billion. That's a little less than five percentage points. And that does make sense, i .e., if they got the drive numbers, if they got all that to the bottom line, which I'm not saying they will, but if they did, that would put them in that ballpark of putting it together with the UPS segments combined the same way.

36:18And then on the consolidated math, they also, in all the analyst stuff about this program and the long -term goals, they're basically talking about $100 billion of revenues, total company, and that's against 85 now, getting to a company -wide 10%, which also looks reasonable on whether you roll up the segments or whether you just look at a UPS or whatever. And that would get you to $30 of earnings power versus the next 12 months, probably going to be 20 bucks. And that's a big part of why we think it's stocks cheap at around 250. But all that does seem to ring true, makes sense. Thinking about that 500 basis points or slightly less than 500 basis points of margin difference from a UPS.

37:02What are the key buckets that that would fall into? And I'll point out labor. There is a difference in terms of UPS labor with the Teamsters recently going through what always seems to happen every five years, which is a too much intense negotiation, but ultimately getting a deal done with some very large increases in terms of the wage inflation. How does that impact FedEx and how does that play into that margin profile overall? First off on the 4 billion, they put that into three roughly equal buckets. Roughly a third of that was going to be in ground, roughly a third in flight, and roughly a third and just back off as GNA procurement, stuff like that, which really didn't have to do as much with one segment carrying freight for another.

37:51That's how they lined out the numbers. And they gave pretty specific stuff on the categories within air and ground and corporate or back office. But you're right, the labor is a very important point. And you're right. UPS has said this is a roughly 3 .3 % increase in labor, but it's going to hit really hard on the front end. And so it has ramifications both for how people are believing or not believing what UPS is going to earn next year. And that matters on relative peer comparison. But that umbrella remains there for FedEx to be lower cost on both ground and freight. Thinking about FedEx and who is leading the business into this next chapter with some of these changes, Fred stepped down in 2022.

38:40too, but there has also been many changes in terms of that leadership team and who's managing the business. So can you talk a little bit about that and who's in charge now, who's overseeing this and how you think about the team that's ultimately in charge of leading the next phase and the potential inflection point? Yeah, it's a very important point because they had one of the most stable executive committees that we've seen on a lot of stuff we follow. And you're right. I mean, this is major chairs of change. So Fred remains executive chairman and in a very active way. So, I mean, I still think of him as full -time, even though he is not the CEO for the first time ever.

39:19Raj Subramaniam is CEO. He's been at FedEx for 30 years. He's been both marketing and ops. He's been all over the world. He entered this job at just an unbelievably interesting time. Within a couple of months, activist D .E. Shaw shows up, and that was their, quote, activist episode of the last couple of years. and Shaw got a few directors, now two directors. So first Raj has that as his welcome to the CEO thing. And then he has what's now this famous guidance cut, his first summer in the job. And I say now famous because at the time he actually caught flack for that because he was ringing an economic bell that others weren't yet.

39:59And then of course now everyone is thinking about are we in a recession or not and what's coming or not. So I mean, if anything, the good FedEx dashboard just rang the bell early. But that led to an air pocket in the stock. And he's also dealt with that. But he's handled it all beautifully, kept his head down, then put in the drive and the one FedEx. And here we go, reducing costs. And then that leads to the CFO change, which is Mike Lenz was CFO for the last few years. And now it's John Dietrich. And the most interesting thing about him is he had not been a CFO or even an accountant in his previous life.

40:32So he comes most recently from Atlas, where he was CEO, where they sold the private equity He really is more of an operator. Before that, he'd been a general counsel, but he's bringing skills that are really about attacking these costs to go with what Raj is tasked with in the shortest term possible. It makes sense to us, and especially on the, we're wildly enthused about share repurchase at this price at $250 when we think it's worth $400. So that part is taken care of, if you will, on the financial side, and it really is just about the execution. And the Treasury Department at FedEx has always been fantastic.

41:06That gives you also confidence about not having a traditional CFO, if you will, in that seat. So we're enthused by this team. In terms of the business itself, where it can go, some of the things that it's looking to do. I think you mentioned a good point earlier in terms of Amazon for customers. If they are going to be your main competitor in terms of selling the same thing that you're selling, it's hard to make them the dependent one who warehouses your inventory, ships your inventory and relying on them 100%. I think it's very easy to see the conflict of interest there. When it comes to logistics operations and ingraining more into businesses logistics, it's always one of those business lines that I thought maybe UPS and FedEx could start to ingrain themselves more with some of these D2C companies or just more in terms of the e -commerce business.

42:00Is that anything that you from an investor have a particular view on in terms of the potential for that in the future, whether it be a positive or a negative and how it might play out for FedEx? That one's interesting in the nuance of logistics in that the third -party logistics as a business is not something we love. It's hard. It's more commodity -ish, and it's very capital -intensive. You and I started talking about the Memphis thing. This is one thing we see in Memphis with this over -the -top industrial warehouse market there. you still see all that activity because you can still be the partner to that logistics firm or to someone's own internal logistics department where you can get embedded you can hopefully drive even part of the IT networks into each other and make it even more efficient but it is different than being that business and they have tried it in the past and it just didn't work out that great I think UPS has more of an affinity for it has probably done a better job with it But long -winded way to say logistics per se is something we don't really want to be in directly, even though, of course, you want to be the provider of choice.

43:07And it's a little bit that on forwarding, which is interesting, too, because for a long time, it was like you're fighting the forwarders as they use the underbelly of passenger jets and other people like that. Well, somewhere in there, FedEx is like, we can do that, too. We don't have to put everything on our own plane, especially if that doesn't make sense on a yield and return basis. So if you look at their category of purchase transportation, when that's not their own contractors over at ground, that's putting it on passenger underbellies and just picking the best route, having the luxury of being more agnostic if it's your plane or not.

43:40So I think that's the same dynamic logistics as being those as adjacencies. Amazing how intertwined the transportation and logistics space actually is in terms of how many of these big players work with one another or ship one with one another or end up in some capacity having ingrained networks and how reliant everyone is on one another. To go back to your investor perspective, I think you referenced before in terms of where the business could go from $20 of earnings per share to $30. Reference that against the stock price today. Is that how you would typically think about this business, just looking at the price to earnings multiple?

44:20How else would you frame thinking about what is fair value for a business like FedEx and relative to whether it's the S &P or anything else in the market? it. There's several ways where really the most important to us would be, I guess the sell side would call this sum of parts. We just say whatever, that's just NAV basically. But in doing the segments, we would look at Express, as I mentioned, which is unbelievably not worth, its value has not grown a lot because these macro problems, but that one we'd be at more like call it two thirds of revenues. Basically that's been in line with DHL. That's in line with what we think will be the normal express margins, even though, as I said, now there are only two, but that leads to a number, call that 30 billion -ish.

45:03And then the freight business is interesting in that we're probably a mid -teens EBITDA on that, which is way below Old Dominion, which is interesting. And that puts us at, call it 25 billion, even though Old Dominion has an EV, I think over 40 billion and it's a lot smaller. Never gets cheap. I know. The returns are a thing of beauty. And then ground, of course, is the most important. And I think if you were doing a sum of parts, there'd be two ways to come at ground. I mean, one is our own longhand gives that a PE of a little more than 20. That is a duopoly. It's an incredible structure. They can keep gaining unit share, all the good stuff we've talked about.

45:41And that works out to 13 to 14 times EBITDA. And that seems to make sense. And if you do that, you would get $75 billion for ground. But the appraiser part of us says you got to honor where UPS sells. And if you could get $15 or $20 billion less for that, if you just said, let's just slap the UPS metrics on it. Now, as an aside, I do feel like because of UPS's earnings momentum that you talked about in the labor deal, there are reasons to us why that for the first time is cheap. This is the first time in comparative values that we've thought it's not just saying put a UPS multiple on FedEx. It's also UPS itself is cheap.

46:16But anyway, time that all together. If you do those numbers, you're talking about around 400 bucks a share. But anytime we do that, you do have to compare that to the straight up EPS number. And what does that imply? And so if we agree that mostly the earnings power there is going to be 30 bucks in a few years, and you discount that back, that's been aligned with our 400. If you did just say straight up UPS comparison. Although if you did that, you might have to do Old Dominion on the freight comparison. If you're going to start doing market peers, that would give you something more like 350 instead of 400, but that's still way above today's stock price.

46:54And I guess the last thing is the sell side stuff that probably drives us most bananas about when it's value in this is the use of the word historical. Sometimes that makes all the sense in the world, The regression to the mean, the historical norm, that makes sense, of course. But when your business has completely changed, it just doesn't. So DHL shows the risks and the macro problems and all that of why that's a low PE that we talked about. Express is just a tougher thing than it's ever been. But this is 20 % express. It doesn't matter what the PE was 10 years ago. It was an express business.

47:31And now it's a U .S. trucking business. And so historical multiples, we throw them out the window because the company has radically changed its makeup. And again, we would get to some combo of UPS and Old Dominion as the right multiples, whether it's EBITDA earnings or revenues. And it's just going to be way above anything here. One last way to look at that is if you just said, take Express out of the equation, FedEx, which the consensus is almost exactly 20 bucks for the next 12, 15 of the 20 bucks is US trucks. So that alone on 250 is not crazy. I, another way to say this and value person parlance is like I get expressed for free.

48:11It may have challenges and headwinds and all that, but it's also got a 2 % margin that can go back to seven once they get some of the stuff sorted out. The starting point in terms of where the margin is today is very important. If you don't believe that it's going to go negative, then it certainly has one direction that's much more interesting and compelling when it comes to the value. I think your point in terms of the secular trend for a multiple is important. And I can specifically remember myself drawing some of those historical multiple charts, looking at something like UPS, where it was just, yes, there was cyclicality in terms of the chart, but it was really one long trend of multiple contraction.

48:50One subsector of transportation that we haven't brought up, which I still believe is seeing multiple expansion over the past two decades, has been the railroads. And it's one of these businesses where you step back and you would have said, well, Matt, look at railroads and what they have going for them in the economy. Everything's getting faster overnight. Doesn't seem like it's that great for railroads. You take something like FedEx and UPS, all of these tailwinds, yet the stock performance tells the real story. Is there anything that you think you could take away from the railroad performance, how they've managed those businesses and apply it into FedEx in terms of what the next 10, 20 years could look like?

49:29That's a great question. And within that, I should have mentioned on these drive savings, some of this one FedEx is not just freight hauling for ground. It's putting a lot more on the rails. They talked about that a lot at the whole analyst day where they talked about this drive program. So I'm very glad you brought that up. So one thing is it does become another avenue for FedEx to benefit from not only worry about the competitive pricing on rail versus trucks. I feel like as somebody who's, boy, we've blown it on not making money on rail. So I say this as a huge maker of mistakes on rail. It feels more like infrastructure to me.

50:08It's slower growth. It's got EBITDA margins that can only go so much further. But it gets this infrastructure multiple because it is. You can attach such a high terminal value to your DCF there that it spits out these huge multiples that, again, we screwed that up. we were still putting low growth multiples on it and we missed it. But I don't think the trucking companies will get that, or at least we're not willing to use those multiples. And they will be somewhat tethered to each other. If we're doing risks for the case, if that gap gets crazy between rail and trucks, that just hurts the two companies, even though somewhat you can use the rail if you're FedEx.

50:44But they have been just a steady performer. And interestingly, one of the directors that D .E. Shaw had put on when they got their activist settlement, for lack of a better word, was a legendary rail guy. He now had to go because he's got another job, but rail's definitely in the mix of the whole discussion. I think the way you phrased it there in terms of the terminal multiple is actually very interesting and very well said in terms of how important that is for rails. and something that you certainly could see if there was some stabilization in the air freight market, whatever category we want to put FedEx and UPS into.

51:24But there's been so much disruption and unease over the past 15 years. But it certainly seems like something that could be in the long term. When you think about risks for FedEx, there's the obvious macro risks, There's integration risks. But what else do you think about most from the investor perspective as a risk for FedEx? I do think it's execution. That's another tried overuse phrase, but I really do. You don't see these major structural worries. So one part would be execution of all that they have on their plate. Another part would be, and you mentioned this earlier, they do have this labor cost advantage.

52:01Well, depending on who's going to be the government, that depends on labor posture, and that depends on what rules change. And so you always have to wonder, could anything change about the regulatory that might change the comparative labor costs? That'd be another one. Amazon's so huge and important to our consumer world that just as a wild card, I don't even know how to articulate what exactly the risk would be. But if something they could do to screw up market structure, fuel's another one. Again, even if you have a fuel charge, your product is still less compelling against whatever the competition is if it spikes.

52:33Between Ukraine, Middle East, whatever, what if oil goes crazy? and then that's going to hurt. Those are all good risks that I think we either touched on lightly or didn't address at all to add into the pile. This has been an excellent conversation. The last question we always ask is around the lessons from studying a business that you think that you could potentially apply elsewhere. So whether it's Fred Smith specifically, FedEx the business over the decades that you've spent looking at it, what are lessons that you think FedEx can teach investors that they can use this in terms of pattern recognition or something else when it comes to diligence?

53:12We've touched on some of them directly or indirectly, but I mean, a couple of them would include this long -term thinking and strategic adaptability. I mean, we talked about this as far as here's this famous, famous, famous thing on airplanes that is really about ground and trucks. That was just adapting. That was a brilliant person and team just adapting. I think that's one. And then related to that would be this long -term thinking, which we also mentioned, just not regarding, I don't care what this is going to do the next quarter earnings if we don't carry Amazon packages. Is that a good thing?

53:44And then as far as investor and my financial nerd self, it'd be the pricing power. We're always going to take our analysts through trying to be proficient and doing a Porter model and all that stuff. But if you try to dummy that down, it is about, and it just covers so many other problems. We've had all this volatility. We've talked about political crises and oil spikes and all this stuff. And they've still tripled their earnings in the last 10 years. And they'll probably double again soon. And if you say, wow, what carried the day? What won it? It's those annual price increases they put through because of this powerful market structure that wasn't an accident that gets back to the adaptable part and the long -term part.

54:23I love that. Market structure has been something that we've been thinking a lot about recently. And it's a theme that obviously we had discussed or looked at, but maybe hadn't paid enough attention to. And a lot of what's going on in the cable market is what's triggering that right now and thinking about how important it can really be for all of the different players in a given industry. So an excellent lesson to close on. Some excellent stories and analysis here. Thank you so much for joining us as someone who has FedEx in their backyard. It goes a little further in terms of the conversation.

54:56So thanks so much, Daley. Thanks a lot. Great to talk to you. Appreciate being on. To find more episodes of Breakdowns ranging from Costco to Visa to Moderna or to sign up for our weekly summary, check out joincolossus .com. That's J -O -I -N -C -O -L -O -S -S -U -S dot com.